Page 264 - DCOM508_CORPORATE_TAX_PLANNING

Unit 11: Tax Planning for Liquidation

Self Assessment Notes

Fill in the blanks:

5. Gain on the property transferred possibly capital gain to the extent that the ………………….
of the property exceeds the income tax basis in the property.
6. The corporation tax accounting period ends immediately before the day of appointment of
the ………………..
7. A ……………..is an organisation that a larger business acquired and allowed to continue
running its operations.

8. At the ……………….level, all shareholders will receive remaining assets after liquidation,
in proportion to their ownership.

Caselet In Real Life, Sometimes the Good Guys Win
onsider the case of William Norwalk and Robert DeMarta when they liquidated
their Fremont, California, CPA firm and traded the equipment, office furniture and

Ctheir client list to a large regional fi rm in exchange for a partnership interest. The
IRS determined their fi rm had realised a $588,000 gain on liquidation of its goodwill and
Norwalk and DeMarta, as shareholder partners, realised capital gains from the distribution
of the goodwill.
The IRS said the distribution of clients was a taxable event. The IRS argued that when the
corporation was liquidated, it distributed to its shareholders “customer-based intangibles”
in addition to tangible assets. The intangible assets at issue included the corporation’s
client base, client records and work papers and goodwill (including going-concern value).
These intangibles, the IRS said, were corporate assets that had a specifi c value and when
distributed to the shareholders in the liquidation, triggered taxable gains for both the
corporation and the shareholders.
The CPAs said the corporation didn’t own the clients. The CPAs argued that the corporation
did not own the intangibles in question. The accountants themselves owned the intangibles,
they said, and therefore no tax was attributable.
Agreements said that clients were assets of the corporation. Prior to the liquidation, the

firm had employment and non-compete agreements with the shareholders, which said,
“Employee recognises and acknowledges that the list of the corporation’s clients, as it may
exist from time to time, is a unique asset of the corporation’s business.” The agreements
prohibited disclosure of the identity of the clients, barred the employee from performing

services for clients outside the firm and set forth penalties for breach of these provisions.
The Tax Court ruled the liquidation not taxable because agreements had lapsed. At the
time the firm liquidated, the agreements had expired and it did not have any effective

employment or non-compete agreements with the two shareholders. Because of this, the
Tax Court held that the distribution of the client base to the shareholders did not result in
a taxable event to either the corporation or to the individuals.
The court found that client lists and goodwill have no “meaningful value” absent an effective
non-compete agreement: “Because there was no enforceable contract which restricted the
practice of any of the accountants at the time of the distribution, their personal goodwill
did not attach to the corporation. Any goodwill transferred to the partnership was that of
Contd...

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